Five Signs a Market is Topping Out

While timing markets is almost always best avoided and always challenging, sometimes it is pretty clear that the momentum of a market is tapering off. This is a good time to lock in gains, reduce exposure and tighten trailing stop losses.

This article published with permission from InvestmentU.com.

It is always a painful “learning” experience.

Like many investors, I have made the unfortunate mistake more than once of investing in booming markets at just the wrong time — right before they go into reverse gear.

While timing markets is almost always best avoided and always challenging, sometimes it is pretty clear that the momentum of a market is tapering off. This is a good time to lock in gains, reduce exposure and tighten trailing stop losses.

Let me share with you the lessons I have learned through hard experience. Here are five signs that a market may very well be topping out.

1. Increased volatility

All markets bounce around a bit and suffer periodic pullbacks. But when you see an increase in choppy trading without a clear uptrend, the yellow lights should start flashing.

2. High relative valuations

The question you should always be asking regarding valuations is “compared to what?” For example, to say a stock is trading at 20 times earnings doesn’t mean much. But if Chile’s stock market is trading at 22 times earnings and Brazil’s is at 12 times earnings and in an uptrend, lean hard toward Brazil.

3. Rising debt

When deals are getting done in a particular sector or country that’s home to more and more debt, it is a sign that bank credit standards are weakening. High corporate debt means higher risk and less room for mistakes.

4. Constant media attention

When a market is constantly in the headlines and is frequently touted by gurus in the financial media, caution should reign. It is far better to have absolutely no one talking about an idea or market.

5. Small cap surge

Most bull runs start with the largest, most liquid companies and end with a small cap surge.

Case Study: Southeast Asia

Many of you know that I’m a huge fan of Southeast Asian markets. I call this bustling region of 600 million rising consumers the “sweet spot of the Pacific century.” Nonetheless, the above five factors all led me to exit Southeast Asian markets a few weeks ago.

Here’s my reasoning…

While coming off a great year in 2012, these markets are erratically bouncing around this year. Their relative valuations were becoming uncomfortable, with the Philippines’ market trading at twice the valuation of China.

On the corporate side, Thai Beverage recently bought Fraser & Neave for $11 billion largely through debt — quadrupling its debt-to-core-earnings ratio. What’s more, a consumer retail bank in Indonesia recently changed hands at more than five times book value and CP Foods (OTC: CPOKY) paid 50 times earnings for wholesaler Siam Makram.

In addition, media attention to this usually overlooked part of the world was at peak levels as investors shunned poorly performing China and Brazil. A typical headline was “Investors Look Beyond China to Southeast Asia.”

Finally, small caps in the region were on fire through early June. The Market Vectors Indonesia Small Cap ETF (NYSE: IDXJ) was up 40% before a sharp pullback.

Always keep in mind that markets, especially emerging markets, move in distinct cycles. As crusty old Joe Kennedy aptly put it, “only a fool holds out for top dollar.”

Carl Delfeld is a senior analyst at InvestmentU.com. See more articles by Carl here.

The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.